In this article I am going to calculate the intrinsic value of Arrow Electronics, Inc. (NYSE:ARW) by taking the foreast future cash flows of the company and discounting them back to today’s value. I will be using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. Please also note that this article was written in January 2019 so be sure check out the updated calculation by following the link below.
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What’s the value?
I’m using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow forecast
| 2019 | 2020 | 2021 | 2022 | 2023 | |
| Levered FCF ($, Millions) | $871.43 | $1.10k | $782.00 | $722.00 | $813.00 |
| Source | Analyst x2 | Analyst x1 | Analyst x1 | Analyst x1 | Analyst x1 |
| Present Value Discounted @ 13.68% | $766.58 | $850.45 | $532.33 | $432.36 | $428.27 |
Present Value of 5-year Cash Flow (PVCF)= US$3.0b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.7%. We discount this to today’s value at a cost of equity of 13.7%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = US$813m × (1 + 2.7%) ÷ (13.7% – 2.7%) = US$7.6b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$7.6b ÷ ( 1 + 13.7%)5 = US$4.0b
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is US$7.0b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of $80.63. Relative to the current share price of $73.4, the stock is about right, perhaps slightly undervalued at a 9.0% discount to what it is available for right now.
Important assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Arrow Electronics as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 13.7%, which is based on a levered beta of 1.506. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Next Steps:
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. For ARW, there are three key aspects you should further examine:
- Financial Health: Does ARW have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does ARW’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of ARW? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. Simply Wall St does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.